A brief history of Bankruptcy Law in America
In 2002, there were over 1,576,000 bankruptcy filings in
the United States.1
For most people, the term bankruptcy is full of dreadful connotations.
It's not a pretty picture when you are in a situation where you cannot
pay your debts and the law takes over for you. On the other hand, it's not
as bad as it once was — The chances of you spending the rest of your life in
debtor's prison are small — if the current bankruptcy laws are properly
applied, the bankruptcy process can consolidate your debts, and provide a
feasible schedule for you to repay them. It hasn't always been this way.
The
term bankruptcy derives from the Italian phrase "banca rotta,"
literally broken bench2. The term comes from medieval
Italy where it was
the practice to deal with a businessman who did not pay his debts by
"breaking" his trading "bench," thus putting him out of
business. Up until the 20th century, the rules regarding bankruptcy were
very harsh and strongly favored the creditor over the debtor. The emphasis
was on retrieving as much of the creditor's investment as possible and very
little regard was given to the effects on the debtor, whose life was often
irrevocably ruined.
The
first official bankruptcy laws in England were passed under the rule of King
Henry VIII in 1542. Under these early bankruptcy laws, the debtor was considered a
criminal and was
subject to penalties ranging from incarceration in a debtor's prison, up to the
death penalty. Originally, bankruptcy law in America was derived from
English statutes, but over time they were modified to accommodate short term
changes in the economy as well as various special interest groups.
The
first federal bankruptcy law in the U.S. was enacted in 1800 specifically to
address excesses in land speculation. These laws were repealed in 1803, and a
new set of bankruptcy laws was passed in 1841, this time in response to the economic panic of
1837. This law was in turn repealed in 1843. The American Civil War was the stimulus for the next bankruptcy law in 1867.
This law lasted until 1878 and was the first to include provisions specifically
addressing corporations. Unlike English law, all of the American bankruptcy laws
contained some provision for the discharge of unpaid debt. This paved the
way for modern bankruptcy laws which include protections for the debtor and
emphasize the concept of rehabilitation of debtors after the bankruptcy
proceedings.
The Bankruptcy Act of 1898 provided for a bankrupt company to be put into an
"equity receivership," that specifically protected the company's assets from creditors. The provisions in the law for
"reorganization" allowed a company to survive a bankruptcy proceeding
and emerge to do business again. The reorganization principles in these early
bankruptcy laws were expanded and formalized during the 1930's in response to
the massive economic upheavals of the Great Depression. Specifically, the
Bankruptcy Acts of 1933 and 1934 were incorporated and extended in the Chandler
Act of 1938. The Chandler Act remained the primary bankruptcy statute until it
was superceded by the Bankruptcy Reform Act of 1978.
The
Bankruptcy Reform Act of 1978 was a significant legislative watershed in
bankruptcy law. It strengthened and consolidated business reorganization
procedures under Chapter 11, and replaced the older personal bankruptcy
regulations with Chapter 13. The Bankruptcy Reform Act of 1978 made it
significantly easier for both businesses and individuals to file for bankruptcy
and seek protection from their creditors. The 1978 law did not cover tax-related
issues and this was addressed in the Bankruptcy Tax Act of 1980. The 1980 law
also addressed issues such as tax loss carry-forwards and taxation rules where
equity is exchanged for debt relief.
Many
felt that the 1978 law went too far in providing protections for the debtor and
in 1982, the U.S. Supreme Court ruled that the expanded jurisdiction of the bankruptcy court was
unconstitutional. This ruling led to the Bankruptcy
Amendment Act of 1984, and reduced the power of the bankruptcy
judges. The
1984 act also limited the rights of companies to terminate labor contracts when
they entered bankruptcy. In 1986, Chapter 12 bankruptcies were created to cover
family farms.
During
the 1980's and early 1990's, record numbers of bankruptcies were filed including
many well known companies such as Texaco, Continental Airlines, Greyhound,
Federated Department Stores and Pan Am. Some of the large multinational
companies that filed for bankruptcy challenged the legal system in demanding
that the insolvency laws of several countries be reconciled. The 1990's also
brought innovation to bankruptcy law in the form of "pre-packaged"
bankruptcies that streamlined the process and allowed the court system to handle
the large volume of cases. The early 1990's also saw a sharp increase in
the use of bankruptcy professionals such as examiners and mediators authorized
by the court to expedite matters and reduce the cost and delay in large
bankruptcy cases.
The Bankruptcy Reform Act of 1994 (Public Law 103-394) is the most significant
change in American bankruptcy legislation since the 1978 Act. The 1994
Act, signed into law by President Clinton on October 22, 1994, contains
provisions affecting business and personal bankruptcy laws. Some areas the
1994 Act addressed specifically expedite bankruptcy proceedings, encourage
consumers to utilize Chapter 13, rather than Chapter 7, to consolidate and reschedule their debt, and assist creditors in recovering claims against
bankrupt estates. The 1994 act also created the National Bankruptcy
Commission to continue looking into needed changes in bankruptcy law. In
November 1997, the Commission completed its first comprehensive review and
delivered a detailed report on recommended reforms.
Further changes in bankruptcy law may be expected as the law evolves to meet
the changing needs of society.
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1 Stats courtesy of the American Bankruptcy Institute:
http://www.abiworld.org/
2 Background information courtesy of: The
2001 Bankruptcy Yearbook & Almanac: http://www.bankruptcydata.com/Yearbook2.htm